Birds and the Bees About
Choosing Your M&A Investment Banker

Birds and the Bees

If you are new to the game, heads up

Founder-owners of middle market companies usually only sell a company once in their life. The rainmakers at investment banks – the “closers” in Glengarry Glen Ross lingo – are skilled at getting new engagements. They pitch one deal after the next. They are polished at making a business owner believe that they are – and will continue to be – their banker. This is financial slight-of-hand to be aware of. Ask them if they will be your day-to-day contact during the life of the deal and watch their reaction and response.


The asymmetry in transaction experience between business owners and street-smart investment bankers leaves the owner vulnerable to the bait-and-switch gamesmanship of “closers”. Let’s lay out some of truths to be aware of before you give you heart to one of them.


Investment bankers only get paid for transactions that they either source or close. Bankers get paid a percentage of the value of their deals, not the firm’s deals. Since teams do not share their success fees with other teams, the financial motivation is to work on one’s own transactions and not assist other teams’ members due to the scarcity of time and other resources. It’s actually worse than just a lack of cooperation. Outperforming the guy next to them is their best path to partner. Because of that, bankers look left, then right, and then work to see that these interlopers are gone. Inter-team assistance is virtually non-existent as a result.


Rainmakers are motivated to sign up as many engagements as possible, not analyze companies. They want velocity, the quickest possible turnover so that they maximize their bonus. They have a financial incentive to get an acceptable price, not the highest price. The latter requires that they really roll up their sleeves and understand how your company will fit with each prospective buyer. That requires a lot of work. It also requires the next ingredient.


The vast majority of investment bankers have never been on the buy-side. They have never had to put together a set of financial projections they were held accountable for, never been involved in merger integration, never hired a CEO, and never had to turnaround a company. It’s hard to give sound advice if you’ve never actually been there, done that.


The person pitching you likely has not done any financial analysis for decades. Bankers that have survived at medium and larger firms are now managing people and client relationships. Their analytical skills have atrophied and they are dependant of the skills assigned to them out of the analyst pool. That makes for a quilt-work of the analytics the firm puts forth, and buyers see it. Their work is not integrated. Sections and paragraphs don’t fit together, and the reader is left to integrate the work themselves rather than being let to an inevitable favorable conclusion. Its like reading a version of The Old Man and the Sea where each chapter was written by a different college team rather than Ernest Hemingway. Its one of those things that hard to define, but you know it when you see it.


If your company is at or below the average size for an investment bank, they will assign junior people to your deal team to give them experience. Unless you are on the upper-end of the bank’s size range and value, you are likely to get “B” and “C” team talent. Being a Guinea pig or analyst trainer is not in your best interest. To get the best outcome, find a bank that specializes not just in your industry, but your size category. PE firms are very specific about the size of deals they will pursue. You need a bank that fits with your company’s size and the investment criteria range for the PEGs that match. The lowest end of the middle starts at $0.5mm in EBITDA and runs to about $2mm. Most lower middle market PE firm start at $2-3mm in EBITDA and run to perhaps $10mm. The majority are looking for double-digit EBITDA margins, so revenue expectations for this segment are roughly $10mm to $100mm. The middle of the middle market starts at roughly $10mm in EBITDA. Revenues at that point are $100mm and go up to $500mm where the upper middle market starts and our interest ends. Once a company hits $200mm in sales or better, it starts to have divisions that require separate diligence and pricing by the banker. Here is where a larger bank comes into play. Below this, it doesn’t help you. Each of these segments is distinct, with it own multiples that buyers are willing to pay due to the separate issues found in each size category. Typical EBITDA multiples paid increase as size increases. As a result, you can’t directly compare the EBITDA multiples paid for companies of different sizes. If your banker does so without adjusting for size, he is either incompetent or you are being mislead.


Bankers covet their buy-side relationships and resist sharing that relationship with other deal teams. Selling a company requires that they market the transaction to buyers where there is a fit. Also, bankers manage these buy-side relationships and have material relationship equity in them that they work hard to maintain. Try to sell a company to the wrong set of prospective buyers and they will put you on their spam list, stop picking up the phone, and terminate your hard-earned relationship. Because of the damage that can be done to a buy-side relationship, relationship bankers do not provide access to their buy-side clients unless it is in their personal interest. Bankers invest a significant amount of time and energy in developing their equity in these relationships. They simply do not permit access without a strong financial incentive, and then, provide access only with direct involvement and protection of the buy-side client.


Companies sell for different multiples depending on their size. This is because the smaller the company, the more numerous the likely weaknesses. These weaknesses include dependence on the owner, customer concentration, smaller geographic footprint, fewer deliverables or products, and a general absence of sophisticated talent acquisition and succession planning. When your banker shows you multiples for companies that are vastly different in size without an appropriate caveat, you are being conned.


Bankers will try to tell you your company is worth more than it really is to win the engagement. Every business owner wants to be told their business is worth a fortune. But a valuation in a pitch is worth exactly what you paid for it. Nothing. The banker has not conducted due diligence. They have barely scratched the surface at the time of the pitch. The hard truth is that even once a good banker has finished doing all their analysis and completed writing the information memorandum, they have still not completed due diligence. Only after the buyer completes their due diligence is the entire truth known. As a result, the earlier you are from that point, the wider the range needs to be to take into account all the possible outcomes.


All that matters is your deal team, not the firm. Think Seal Team, not Army Reserves. A smaller well trained, fast moving team will beat out a slower, larger, less well trained force. Due to the incentive comp, the only deal experience that matters, including industry experience, is that which belongs to your team members. Banks operate in discrete silos. If your banker tries to impress you with all the deals that his firm has done, ask him which ones he was the primary banker for. Watch the pupils dilate. Also, beware the bait-and-switch rainmaker. His job is business development. The more senior he is in the firm, the more likely he will not do any work on your deal after the engagement letter is signed. How important is experience? Entire investment banks have been created by a single rainmaker leaving a bulge-bracket firm with a deal team. Evercore, Greenhill and Moelis come to mind.


Lifetime experience matters. There is a reason that 35 year-olds aren’t running investment banks. They just don’t have the deal experience, credibility, and relationships that give them access to buyers. They can be good at running a group of analysts, but that is where it stops. As far as doing the negotiations in transactions, this is the purview of senior bankers. A good senior banker can just sense the situation. More junior people simply miss the queues. There are just too many tricks to the trade, and too many ways that a sophisticated buyer can take advantage of a first-time seller and less-than-senior team. Younger bankers operate out of their firm’s three-ring binder. This helps junior bankers, and they do well with plain vanilla, but if you need creativity and innovation, you need to find someone that has exhibited this during their career. Buyers are motivated to take advantage of color-by-number bankers, and whoever has the greater experience and creativity will win the day. Sun Tzu knew this well.


Most lower middle-market firms close relatively few transactions, and that is a good thing if you have “A” team talent and they are focused on you. The relatively small average number of transactions per firm (2-3)1 is due to the small number of team members needed to optimize the execution of the sale process of a lower middle-market company, from $2mm to $20mm in EBITDA. A deal team size of four is all that is needed. This includes one senior banker and his analysts and intermediate members. A full-time senior banker guides the team and, hopefully, is the ultimate analyst, writer, marketer, daily contact and deal guy. Experience counts, which leads us to our next point.


Investment banks are much like large law firms. Your corporate lawyer is really independent of the firm. The firm simply provides infrastructure. If your corporate attorney seeks counsel from another of the firm’s attorneys, that attorney bills for his time. As a result, attorneys operate within distinct and separate silos with your attorney working with his associates. Investment banking is the same. There are fairly famous examples of investment banks sprouting up virtually overnight due to a well-connected and regarded investment banker leaving a bulge-bracket firm with a deal team and setting up shop. Evercore and Greenhill are examples. Oh, and like the law firm, if you find that your attorney’s associates are the ones returning your calls, you’ve been assigned to the “B” team.


It is for these reasons we consider ourselves unique. We started on the buy-side. We were held accountable for our projections and ultimate outcome. WE had to compare projections to actual results for the life of the deal (doing this for a decade was a painful but enlightening experience). We had to fix our own problems. We sweated and worried and worked like madmen if things went South like they did in 1991. This pain caused learning that is irreplaceable. You cannot have empathy if you have not experienced the same pain. We have.


As a small firm that originated on the buy-side, we see things from your – and the buyers – point of view in a way other firms just can’t. We do our own projections using all past history and current competitor and industry information available, just like the buyer will. We personally possess control over each and every relationship with our buy-side clients. We do not have to consult with anyone before having contact with them. We personally control our human resources and dedicate them to a single transaction during the sale process rather than having them work on numerous transactions simultaneously. Unlike other firms which assign the work of a transaction to numerous low level analysts and then attempt to integrate the individual disparate parts, a senior banker conducts all analytical work and conducts all writing to ensure both accuracy and consistency in our work. We use our analysts solely for research, information acquisition, and formatting. Having been on the buy-side, we know what can go wrong. We’ve felt what you’ve felt. And having been there, part of our goal is to see you gain from the learning we’ve already paid for.


Footnotes

1. Pepperdine University Private Capital Markets Study